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DBCI: Travis Ferguson on Chancery Extends Role of Statutory Defenses in Section 220 Demand Actions

In the September 28, 2016 edition of the Delaware Business Court Insider, LRC associate Travis Ferguson writes that the Chancery Court Extends Role of Statutory Defenses in Section 220 Demand Actions, noting that the Delaware Court of Chancery has held that there was no credible basis to infer a potential Caremark claim for breach of fiduciary duty for failure to exercise oversight where the stockholder’s only identified use of corporate books and records was to investigate mismanagement or wrongdoing to evaluate potential litigation and the board’s actions ultimately would be “fully protected” by 8 Del. C. Section 141(e).

Chancery Extends Role of Statutory Defenses in Section 220 Demand Actions

By Travis J. Ferguson

In Beatrice Corwin Living Irrevocable Trust v. Pfizer, C.A. No. 10425-JL, (Del. Ch. Aug. 31, 2016), the Delaware Court of Chancery held that there was no credible basis to infer a potential Caremark claim for breach of fiduciary duty for failure to exercise oversight where the stockholder’s only identified use of corporate books and records was to investigate mismanagement or wrongdoing to evaluate potential litigation and the board’s actions ultimately would be “fully protected” by 8 Del. C. Section 141(e). In a post-trial memorandum opinion, Judge Abigail LeGrow, sitting by designation as a vice chancellor, applied the reasoning of SEPTA v. Abbvie, 2015 Del. Ch. LEXIS 110, at *1 (Del. Ch. Apr. 15, 2015), aff’d, 132 A.3d 1 (Del. 2016), and extended the court’s recent jurisprudence concerning statutory defenses in the context of demands to inspect corporate books and records.

The Corwin action arose after a stockholder-trustee plaintiff read an article published in The New York Times identifying Pfizer Inc. as a large multinational corporation that does not calculate its “repatriation tax” liability because it is not practicable to do so. Repatriation tax refers to foreign earnings that are “indefinitely reinvested” overseas and are not taxed under the U.S. tax laws until those accumulated earnings are repatriated to the United States. Indeed, Pfizer’s 2013 annual report indicated it made no tax provision for its international subsidiaries’ approximate $69 billion of earnings, noting these earnings were “intended to be indefinitely reinvested overseas” and the determination of any tax liability relating to these earnings was not practicable. On its face, Pfizer’s statement with its repatriation tax liability appeared to comply with Accounting Standards Codification 740-30, which does not require a company to report any deferred repatriation tax liability if the company states that the calculation would not be practicable. Notably, the term “practicable” is not defined by accounting standards. Pfizer’s 2013 annual report also indicated that Pfizer’s audit committee approved Pfizer’s financial statements after meeting with KPMG LLP, who gave an unqualified opinion to the audit committee and Pfizer’s board of directors that Pfizer’s 2013 financial statements were “free of material misstatement” and in conformity with generally accepted accounting practices (GAAP).

Nevertheless, the trustees of the Beatrice Corwin Living Irrevocable Trust made an inspection demand on Pfizer. The trustees sought to inspect Pfizer’s books and records to, among other things, evaluate potential derivative litigation, including possible claims for breach of fiduciary duty by Pfizer’s board for failing to assure compliance with applicable accounting rules. The trustees requested Pfizer’s board and committee meeting minutes discussing: Pfizer’s repatriation tax liability; The New York Times article; and other related topics that track or calculate Pfizer’s foreign earnings and the costs to repatriate foreign earnings. Pfizer denied the demand on the grounds that it failed to articulate a credible basis from which possible mismanagement or wrongdoing could be inferred.

The trustees subsequently filed an action under 8 Del. C. Section 220 to enforce its inspection rights. The complaint alleged the trustees had reason to believe Pfizer’s board, and unidentified “others,” breached their fiduciary duties by failing to comply with GAAP. In essence, the trustees’ intent was to investigate a potential Caremark claim against Pfizer’s board for its overall compliance with GAAP, specifically focusing on Pfizer’s decision not to calculate its repatriation tax liability. At trial, the trustees’ expert witness acknowledged that defining the term “practicable” requires an accountant’s professional judgment and also testified that he could not disagree with KPMG’s unqualified audit opinion that Pfizer’s 2013 financial statements were consistent with GAAP. The court ultimately held even if the trustees established Pfizer’s calculation of its repatriation tax liability was practicable, the trustees had not offered a credible basis from which to infer the board engaged in wrongdoing or mismanagement in connection with approving Pfizer’s financial disclosures or assuring the company’s GAAP compliance.

In its analysis, the court set forth the well-established standard that if a stockholder’s stated purpose for an inspection of books and records is to investigate mismanagement for potential litigation she must provide some evidence to suggest a credible basis from which the court could infer such mismanagement or other wrongdoing. As it relates to a Caremark claim, the court explained the “credible basis” standard generally requiring the stockholder to provide “some evidence from which the court may infer that they board utterly failed to implement a reporting system or ignored red flags.” In this instance, the court found the trustees’ evidence did not address Pfizer’s reporting systems or whether any red flags were ignored by Pfizer’s board and accordingly failed to connect the alleged inaccuracy of Pfizer’s “not practicable” statement with the board’s awareness of such inaccuracy.

More importantly, however, the court also held the trustees could not establish a credible basis because the trustees’ evidence did not address the board’s reliance on the KPMG audit opinion or the impact it would have on a potential Caremark claim given that the Board was “fully protected” under 8 Del. C. Section 141(e) to rely in good faith on KPMG’s unqualified opinion that Pfizer’s financial statements were prepared in accordance with GAAP. The court reasoned this holding was consistent with Abbvie (affirmed by the Delaware Supreme Court) that when a stockholder seeks to investigate mismanagement or wrongdoing solely for potential litigation the stockholder must present evidence of “actionable corporate wrongdoing.” Specifically, the court in Abbvie held that a stockholder did not have a credible basis to investigate corporate mismanagement or wrongdoing where the only use identified for the inspection was to help plead a later claim in litigation, the only available relief identified by the stockholder was monetary damages, and the directors subject to the potential suit were protected by an exculpation provision pursuant to 8 Del. C. Section 102(b)(7). InAbbvie, it was the Section 102(b)(7) exculpation for any potential duty of care claim that precluded a finding of “actionable corporate wrongdoing.” Likewise, in Corwin, Section 141(e) necessitated a finding that there was no “actionable corporate wrongdoing” because the directors that were the target of the trustees’ investigation were protected from a potential Caremark claim by relying in good faith on KPMG’s unqualified audit opinion.

The court also distinguished the circumstances in Corwin from those present in Amalgamated Bank v. Yahoo, 132 A.3d 752 (Del. Ch. 2016). In Yahoo, unlike the circumstances in Corwin, the focus of the stockholder’s investigation included members of management who were not subject to the Section 102(b)(7) or Section 141(e) statutory defenses and the stockholder’s purpose was not solely to investigate mismanagement to evaluate potential litigation. In an effort to position the circumstances closer to those in Yahoo, the trustees argued post-trial for the first time that it also was seeking to investigate mismanagement by Pfizer’s management, including its chief executive officer, demonstrated by the complaint’s reference “others.” However, the court quickly dispatched the trustees’ argument, noting that throughout the litigation the trustees’ focused on mismanagement and wrongdoing at the board level with little mention of management. Even more, the demand was narrowly tailored to seek documents relating to the conduct of Pfizer’s board to determine if its members had breached their fiduciary duties. The court held that the trustees’ “creeping expansion” for its reasons to investigate Pfizer’s books and records is both unfair to Pfizer and inconsistent with Delaware law.

The Corwin decision illustrates the delicate balance of stockholders’ rights to obtain information under 8 Del. C. Secton 220 and the rights of directors to manage the corporation without undue interference. As the court noted, the “stockholder is the master of his demand” and “requiring specificity in the demand and holding a stockholder to the purposes identified in the demand is not an unfair result.” In addition, the court’s extension of Abbvie to circumstances involving Section 141(e)’s statutory defense again puts stockholders on notice that inspection rights does not permit fishing expeditions into director conduct. Rather, prior to making an inspection demand a stockholder must, to the best of her ability, understand the nature of the post-inspection litigation it may commence and determine whether those claims are subject to any defenses that may affect her inspection rights.

Travis J. Ferguson is an associate at Landis Rath & Cobb LLP where he concentrates his practice on corporate litigation, corporate bankruptcy and restructuring, and bankruptcy litigation.  He can be contacted at 302-467-4412 or at

Reprinted with permission from the September 28, 2016 issue of the Delaware Business Court Insider. © 2016 ALM Media Properties. Further duplication without permission is prohibited.